When a borrower defaults on his or her student loans, the lender may
add collection charges to the cost of the
loan. Usually the collection charges are deducted from each payment
before the remainder is applied to the interest, fee and principal
balance of the debt. But sometimes collection charges are added to the
loan balance.

Collection charges are usually expressed as a percentage of the amount
applied to the principal and interest balance of the loan. For
example, if a defaulted borrower wishes to pay off his or her debt,
this is the amount that must be added to the current loan balance to
yield the payoff amount. Collection charges may also be expressed as
a percentage of the total amount paid by the borrower.

The two figures are mathematically related. If D is the percentage
deducted from the loan payment and P is the percentage of the amount
applied to principal and interest, then D = P / (1 - P) and P = D / (1
+ D). For example, if the collection charge rate is up to 25% of the
payment amount, then the collection charges represent up to 25% / (1 +
25%) = 20% of the principal and interest portion of the payment.

A portion of the collection charges are paid to collection agencies
who receive a commission based on the amount recovered. This gives the
collection agencies an incentive to recover as much of the debt as
possible. This also means that the collection agencies may not inform
the borrower about less expensive repayment options, such as
income-based repayment.

Collection charges are based on the average cost of recovering
defaulted loans, not the actual cost of recovering the particular
borrower's defaulted loan.

Current Collection Charge Rates

The current collection charges on defaulted federal Stafford, PLUS and
consolidation loans is 19.58% of the payment. This is the equivalent
of a payoff amount that adds 24.34% to the balance of the loan.

The Perkins loan has a higher collection charge rate, in part because
the average defaulted Perkins loan balance is much smaller. The
collection charges are 30% of the principal, interest and late charges
for first collection attempts and 40% for subsequent collection
attempts. Collection charges on a defaulted Perkins loan repaid
through rehabilitation are capped at 24%.

Historical Collection Charge Rates

In response to a 2012 Freedom of Information Act (FOIA) request, the US
Department of Education provided the following information:

Before March 1995, the collection charges were based on actual charges from
collection agencies, without any limits.

From March 1995 through April 2008, the collection charges were 20% of
the amount paid (25% payoff).

From May 2008 to the present, the collection charges were reduced
to 19.58% of the amount paid (24.34% payoff).

Unfortunately, this response is not entirely accurate. While the
collection charges from May 2008 to the present are indeed 19.58%
(24.34% payoff), as
documented by a May 2008 letter to guarantee agencies,
the collection charges for FY2007 were 19.36% (24.0% payoff) as
documented by a March 2007 letter to guarantee agencies.
The US Department of Education has not yet responded to questions
concerning this discrepancy.

Several guarantee agencies stated that they did not retain copies of
previous letters from the US Department of Education concerning
caps on collection charges.

Reverse engineering the repayment history of a defaulted borrower
yields the following collection charges at a particular guarantee
agency. Notice how the collection charges almost doubled from 2004 to
2007.

Year

Percentage ofTotal Payment

Percentage ofPrincipal and Interest

2012

20.0%

25.0%

2011

20.0%

25.0%

2010

20.0%

25.0%

2009

20.0%

25.0%

2008

20.0%

25.0%

2007

20.0%

25.0%

2006

16.2%

19.4%

2005

13.2%

15.2%

2004

12.1%

13.8%

Statutory and Regulatory Basis

Section 484A(b) of the Higher Education Act of 1965 [20 USC 1091b(b)]
specifies that borrowers who have defaulted on federal student loans
shall be required to pay "reasonable collection costs". A similar
requirement appears in section 455(d)(5) of the Higher Education Act
of 1965 [20 USC 1087e(d)(5)].

The Higher Education Act of 1965 does not, however, define reasonable
collection costs.

Reasonable collection costs are defined in the regulations at 34 CFR
682.410(b)(2) as including attorney's fees, collection agency charges
and court costs. The reference to 34 CFR 682.401(b)(27) concerns
defaulted loans that were paid off by a consolidation loan. The
reference to 682.405(b)(1)(vi) is to defaulted loans that are repaid
through rehabilitation.

Collection charges. Whether or not provided for in the borrower's
promissory note and subject to any limitation on the amount of those
costs in that note, the guaranty agency shall charge a borrower an
amount equal to reasonable costs incurred by the agency in collecting
a loan on which the agency has paid a default or bankruptcy
claim. These costs may include, but are not limited to, all attorney's
fees, collection agency charges, and court costs. Except as provided
in 682.401(b)(27) and 682.405(b)(1)(iv), the amount charged a borrower
must equal the lesser of

(i) The amount the same borrower would be charged for the cost of
collection under the formula in 34 CFR 30.60; or

(ii) The amount the same borrower would be charged for the cost of
collection if the loan was held by the U.S. Department of Education.

The regulations at 34 CFR 30.60, which were referenced by 34 CFR
682.410(b)(2), provide additional detail.

What costs does the Secretary impose on delinquent debtors?

(a) The Secretary may charge a debtor for the costs associated with
the collection of a particular debt. These costs include, but are not
limited to

(5) Costs associated with computer operations and other costs
associated with the maintenance of records;

(6) Bank charges;

(7) Collection agency costs;

(8) Court costs and attorney fees; and

(9) Costs charged by other Governmental agencies.

(b) Notwithstanding any provision of State law, if the Secretary uses
a collection agency to collect a debt on a contingent fee basis, the
Secretary charges the debtor, and collects through the agency, an
amount sufficient to recover

(1) The entire amount of the debt; and

(2) The amount that the Secretary is required to pay the agency for
its collection services.

(c)(1) The amount recovered under paragraph (b) of this section is the
entire amount of the debt, multiplied by the following fraction: 1 / (1 - cr).

(2) In paragraph (c)(1) of this section, cr equals the commission rate
the Department pays to the collection agency.

(d) If the Secretary uses more than one collection agency to collect
similar debts, the commission rate (cr) described in paragraph (c)(2)
of this section is calculated as a weighted average of the commission
rates charged by all collection agencies collecting similar debts,
computed for each fiscal year based on the formula Sum(i=1..N,(Xi * Yi
/ Z)) where

(1) Xi equals the dollar amount of similar debts placed by the
Department with an individual collection agency as of the end of the
preceding fiscal year;

(2) Yi equals the commission rate the Department pays to that
collection agency for the collection of the similar debts;

(3) Z equals the dollar amount of similar debts placed by the
Department with all collection agencies as of the end of the preceding
fiscal year; and

(4) N equals the number of collection agencies with which the
Secretary has placed similar debts as of the end of the preceding
fiscal year.

(e) If a debtor has agreed under a repayment or settlement agreement
with the Secretary to pay costs associated with the collection of a
debt at a specified amount or rate, the Secretary collects those costs
in accordance with the agreement.

(f) The Secretary does not impose collection costs against State or
local governments under paragraphs (a) through (d) of this section.

These regulations specify that the collection charges may be based on
a weighted average of the contingent fees charged by collection
agencies. They do not specify that collection charges may be based on
the average of all costs associated with collecting defaulted loans,
as opposed to the actual costs. The preamble of the final rule, as
published in the Federal Register (Federal Register
57(244):60311-60312, December 18, 1992), indicated that a flat
collection cost rate is permitted.

Section 682.410(b)(2)

Comment: Many commenters objected to the requirement that a guaranty
agency must assess collection charges against the borrower. Other
commenters stated that if collection charges had to be assessed, a
flat rate should be used by each guaranty agency.

Discussion: The statute clearly specifies that, notwithstanding any
provision of State law to the contrary, collection charges must be
assessed against the borrower. See section 484A(b) of the Act. The
formula referenced in 682.410(b)(2) specifies that the amount charged
will be the lesser of the costs of collection under the formula in 34
CFR 30.60 or the amount the borrower would be charged if the loan was
held by the Department. This amount will be a percentage of the
principal and interest outstanding, may be calculated annually, and
would be a flat rate assessed against all borrowers with defaulted
loans held by that agency.

The Higher Education Reconciliation Act of 2005 (P.L. 109-171) amended
section 428(c)(6)(B) of the Higher Education Act of 1965 [20 USC
1078(c)(6)(B)] to cap the amount of collection charges that may be
added to the loan balance when a default loan is paid off through
consolidation at 18.5% of the outstanding principal and
interest. Similar language was added to section 428F(a)(1)(D) of the
Higher Education Act of 1965 [20 USC 1078-6(a)(1)(D)] in connection
with defaulted loans that were sold after rehabilitation.

The regulations at 34 CFR 674.45(e) specify that the collection
charges on defaulted Perkins loans may be based on either actual or
average costs. The regulations also specify the 30% (first collection
attempt) and 40% (subsequent collection attempt) caps on the
collection charges. These percentages are of the amounts applied to
principal, interest and late charges. The corresponding percentages of
the total payment are 23.1% and 28.6%, respectively. These regulations
have been in effect since July 1, 2008. Before this date there were no
caps on collection charges in the Perkins loan program, other than a
cap on collection charges for defaulted Perkins loans repaid through
rehabilitation. The regulations at 674.39(c)(1) cap collection charges
at 24% on a loan repaid through rehabilitation (19.4% of the total
amount paid). However, the promissory notes for many Perkins loans
made from 1981 through 1986 limited collection costs to 25% of the
outstanding principal and interest due on the loan.

Tools and Resources

FinAid provides two calculators relating to collection charges. The
Loan Default Calculator
shows the impact of collection charges on the repayment trajectory of
the loan. For example, an unsubsidized Stafford loan that would
normally take 10 years to repay will take 17 years with the same
monthly payment after subtracting 20% collection charges from each
payment. The
Collection Cost Impact Chart
shows similar results but for a range of loan terms.